VAT on deposits: when do you need to pay HMRC?

If you run a VAT-registered business, you might occasionally ask customers to pay a deposit before you provide goods or services. It’s a sensible way to secure bookings, cover upfront costs or protect yourself against cancellations.

But what happens when you receive the money? Do you need to charge VAT immediately, or can you wait until you’ve completed the work?

The answer depends on what the deposit is for. In most cases, VAT on deposits becomes due before you’ve supplied anything. However, there are exceptions, particularly when you’re holding money as security.

Let’s look at the rules.

Do you have to charge VAT on a deposit?

If a customer pays you a deposit towards goods or services you’re going to supply, you’ll normally need to account for VAT on that payment.

For example, suppose you’re a builder and a customer agrees to pay £6,000 for some work. You ask for a £1,200 deposit before starting. Assuming you’re VAT-registered and the work is standard-rated, VAT is due on the deposit even though you haven’t begun the job.

The remaining VAT will become due when the relevant tax point arises for the balance.

However, not every deposit is treated as an advance payment. Sometimes you might hold money purely as security, with no intention of using it towards the purchase price. We’ll explain how these deposits are treated shortly.

When is VAT due on a deposit?

To understand when VAT on deposits becomes due, you need to know about something called a VAT tax point.

This is the date when you have to account for VAT on a transaction. It determines which VAT return the transaction belongs in.

Under HMRC’s rules for advance payments and deposits, the tax point is normally whichever happens first:

• You issue a VAT invoice for the deposit.
• You receive the deposit from your customer.

Suppose you issue a VAT invoice for a deposit on 20th October, but your customer doesn’t pay until 5th November. The tax point is 20th October.

If you receive the payment on 20 October and don’t issue a VAT invoice until 5 November, the tax point is 20th October again.

Either way, you’ll normally include the VAT on your return for the period containing 20th October.

If you’re using the VAT Cash Accounting Scheme, different timing rules apply. Under that scheme, you generally account for VAT when you receive payment rather than when you issue an invoice.

How much VAT should you charge on a deposit?

The amount depends on the VAT treatment of the goods or services you’re supplying.

If your sale is standard-rated, you’ll normally charge VAT at 20%. If it qualifies for a reduced rate or zero rate, that treatment will generally apply to the advance payment too.

Let’s take a simple example.

You’ve agreed to supply goods for £6,000, including VAT at 20%. Your customer subsequently pays a deposit of £1,200, also including VAT.

That deposit breaks down as follows:

• Deposit excluding VAT: £1,000
• VAT at 20%: £200
• Total deposit received: £1,200

You’ll therefore need to account for £200 of VAT when the tax point arises.

Remember that if you’ve agreed a VAT-inclusive deposit, you shouldn’t simply add another 20% to the amount received. Instead, you can work out the VAT element by dividing the gross payment by six, provided the supply is standard-rated.

Do you charge VAT on refundable deposits?

This is where the rules become a little more complicated.

Some deposits are genuine security payments rather than advance payments towards goods or services. In these circumstances, you might not have to account for VAT when you receive the money.

Imagine you hire equipment to customers and ask for a £300 security deposit. You return the full amount when the equipment comes back undamaged.

Because you’re holding the money as security, rather than accepting it as payment for the hire, the deposit isn’t normally subject to VAT.

The same applies if you retain some or all of that security deposit purely to compensate yourself for loss or damage to the equipment.

HMRC explains these exceptions in section 14.2.3 of VAT Notice 700.

However, a deposit isn’t automatically outside the scope of VAT just because it’s refundable.

For example, you might take a refundable deposit towards a customer’s future purchase. If the money is an advance payment towards an identifiable supply, VAT will generally become due when you receive it or issue a VAT invoice, whichever happens first.

The distinction depends on the purpose of the payment and the terms you’ve agreed with your customer.

What happens to VAT if your customer cancels?

Suppose a customer pays you a deposit to reserve goods or book a service. They subsequently change their mind and cancel.

Can you reclaim the VAT you’ve already accounted for?

That depends on whether you return the money.

If you keep the deposit

If the deposit was an advance payment towards a taxable supply, VAT generally remains due even if the customer never receives the goods or services.

For example, imagine you’ve taken a £600 deposit, including £100 VAT, for a standard-rated service. Your customer cancels and, under your agreed terms, you retain the deposit.

You can’t simply remove the £100 from your VAT return because the service didn’t go ahead.

HMRC’s rules make clear that VAT remains due on forfeited advance payments, even when the customer fails to take up the goods or services.

This is different from retaining a genuine security deposit to compensate for loss or damage, as explained above.

If you refund the deposit

If you return the customer’s advance payment, you can normally adjust the VAT you’ve accounted for.

For example, if you refund the full £600 from our previous example, you can also recover the £100 VAT previously declared.

HMRC says you can reclaim the VAT on your next return after making the refund.

You’ll need to keep appropriate records of the cancellation, refund and VAT adjustment. If you’ve issued a VAT invoice, you may also need to issue a credit note.

What if your customer pays the balance later?

Receiving a deposit doesn’t mean you’ll automatically have to account for VAT on the full sale immediately.

Instead, the deposit and subsequent payments can create separate tax points.

Let’s return to our earlier example of goods costing £6,000, including VAT.

Your customer pays a £1,200 deposit in October. You account for £200 VAT at the relevant tax point.

They then pay the remaining £4,800 in November, before you deliver the goods. This creates another tax point for the balance, assuming you haven’t already issued a VAT invoice that creates an earlier tax point.

The remaining payment includes £800 VAT, which you’ll account for in the relevant period.

By the time you’ve received both payments, you’ll have accounted for the full £1,000 VAT due on the £6,000 sale.

You don’t need to charge VAT on the deposit again when you issue the final invoice. Just make sure your records clearly identify the amount already paid and the VAT accounted for.

Keeping accurate records of VAT on deposits

If you regularly take deposits or advance payments, you’ll need to keep track of when you receive them and how they’re treated for VAT purposes.

It’s particularly important to distinguish money received towards future sales from genuine security deposits. You’ll also need to record subsequent payments, refunds and cancellations correctly.

Your VAT invoices must contain the required information, including the tax point where it differs from the invoice date.

If you use accounting software, make sure deposits are recorded correctly rather than automatically treating every payment as an ordinary sale.

Otherwise, you could end up declaring VAT in the wrong accounting period or paying HMRC more than you owe.

Need help with VAT on deposits?

VAT on deposits can be confusing, particularly if you take advance payments regularly or deal with refundable security deposits.

At THP Chartered Accountants, we can help you understand the rules, account for deposits correctly and make sure your VAT returns are accurate.

To find out more, take a look at our VAT returns service or get in touch with our friendly team.